I found the problem. After I restored the image I got click happy and cleared out some files with CCleaner (System Temp). Boo, boo! The appcompat.txt needs to be in that location so windows will update. How svchost is related to this I don't know. Maybe svchost needs to talk to that file.

I tested this by restoring the image again, and leaving CCleaner alone. And low and behold, I was able to get my windows updates.

But here is a HijackThis log anyway just to make sure. Thank you very much.